Investment Policy Statement - A monthly review of the markets
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February 2020
Investment Policy Statement
A monthly review of the markets
After strong returns across most asset classes last year, it
appeared moving into 2020 that many of the macroeconomic
risks from 2019 had been, if not resolved, then diminished.
US GDP growth and employment data entered 2020 on a
solid path; US equity markets hit all-time highs; the trade
war tensions between the US and China eased as “a phase
one” deal was signed in January; and finally, uncertainty
Coronavirus Impact Across Asset Classes: surrounding Brexit receded as the UK exited the European
Will Uncertainties Mask the Differential? Union on January 31, 2020. Other data were more mixed,
as Europe saw ongoing weakness in manufacturing though
survey data had turned higher. Nevertheless, fundamentals
“The oldest and strongest emotion of mankind is fear, for 2020 appeared generally positive, with slow, steady
and the oldest and strongest kind of fear is fear of the growth creating favorable conditions for risk assets.
unknown.”
-H.P. Lovecraft News from central China abruptly changed that narrative.
The initial reports and impact of the coronavirus (officially
named “COVID-19”) evolved rapidly, and the subsequent
spread of the respiratory illness disrupted the global
economy and plunged equity markets into turmoil.
Amid alarming headlines and TV screens flashing red, we
think it’s important to place the current volatility into context.
First, the choppy markets in 2020 have followed very robust
returns across a range of asset classes in 2019. Figure 1 shows
returns for a broad set of indices, including equities and fixed
income markets, for 2019 and year-to-date through March 3,
2020. We believe it’s important to remember that the abrupt
declines in US and global stocks are on the heels of strong
performance in 2019. Even with the declines in 2020, equity
indices are still substantially higher than at the beginning
of 2019: the closing price of the S&P 500 Index on March 3,
2020 is almost 20% higher than the close on January 2, 2019.¹
¹Source: Bloomberg
1 • Stone Harbor Investment Partners / Investment Policy StatementFirgure 1: A Tale of Two Time Periods
Category 2019 Return (%) YTD 2020 Return (%)
US Equities +33.1 -7.8
Global Equities +28.4 -7.3
Emerging Markets Debt - USD +15.0 +1.9
Emerging Markets Debt - Local Currency +13.5 -1.9
Emerging Markets Corporate Bonds +13.1 +2.0
European High Yield +14.1 -0.8
US High Yield +14.4 -0.5
Broad US Bond Market +6.3 +4.2
Broad Global Bond Market +6.8 +3.3
Data as of 3 March 2020.
US Equities represented by the S&P 500 Index. Global Equities represented by the MSCI World Index. Emerging Markets Debt - USD represented by the J.P. Morgan EMBI Global
Diversified Index. Emerging Markets Debt - Local Currency represented by the J.P. Morgan GBI-EM Global Diversified Index. Emerging Markets Corporate Bonds represented
by the J.P. Morgan Corporate Emerging Markets Bond Broad Diversified Index. European High Yield represented by the ICE Bank of America Merrill Lynch European Currency
High Yield 2% Constrained Ex-Financial Index. US High Yield represented by the ICE Bank of America Merrill Lynch US High Yield Constrained Index. Broad US Bond Market
represented by the Bloomberg Barclays US Aggregate Index. Broad Global Bond Market represented by the Bloomberg Barclays Global Aggregate Index.
Past performance is not a guarantee of future results. Index performance is calculated on a total return basis with dividends reinvested and do not reflect the impact of
management fees. Investments may not be made directly in an index. For illustrative purposes only.
Source: Bloomberg, MSCI
Figure 1 also demonstrates that in times of market stress, Overall, the situation remains fluid, and we are monitoring
asset classes are not always correlated. While in 2019 major the incoming information and economic data closely to
equity and bond indices all generated positive returns for try to understand the reach, duration and impact of the
the year, 2020 has presented a different story. As equity coronavirus on the global economy. We expect risk assets will
markets plummeted, broad US and global bond markets— continue to be very sensitive to that incoming information.
represented by the Bloomberg Barclays US Aggregate Index As the coronavirus continues to spread around the world
and the Bloomberg Barclays Global Aggregate Index— in 2020, central banks that have policy room, a concept we
generated positive returns for the first two months of the discussed in this space last year, appear likely to use it to
year. In addition, US dollar-denominated emerging markets offset some of the downside risks of the coronavirus to the
debt (EMD) also generated a positive return, though local global economy. The Federal Reserve (“Fed”) has already
currency-denominated EMD declined, primarily due to the cut its key benchmark rate by 50 basis points, and indicated
effects of the strengthening US dollar. Even the decline of that further action could be taken depending on conditions.
local currency EMD in 2020 follows 2019’s double-digit Following the Fed’s lead, the Bank of Canada and the Reserve
positive performance for the asset class. Again, we believe Bank of Australia both cut rates as well. Many emerging
that it’s important to keep this level of volatility in perspective.
markets (EM) countries have rates well above zero, and
hence room to cut rates too. Though monetary policy cannot
One area we continue to watch is the effect of the fully offset economic damage if the coronavirus spreads
coronavirus on oil and commodity prices. China is the world’s further, it does provide an important, though partial, offset.
second-largest consumer of oil and is the world’s largest
oil importer.² As a result, a slowdown in China due to the
coronavirus will likely have an outsized effect on crude oil
and commodity prices. In the first two months of 2020, Brent
crude oil prices fell by close to 22%, from a closing price
of $66.25 per barrel on January 2, 2020 to a closing price
of $51.86 on March 3, 2020.³ Historically, lower oil prices
have been a boon to the US economy, providing relief to the
wallets of drivers and boosting real consumption. With the
boom in US oil production over the past decade, however,
the effects are much more nuanced. Lower oil prices tend
to suppress mining investment, offsetting a good chunk of
the boost to the consumer. In today’s economy, the level of
interconnectivity means that a virus that originated halfway
around the world in China could lead to pain in West Texas.
²Source: Bloomberg
³Source: Bloomberg
2 • Stone Harbor Investment Partners / Investment Policy StatementUS MACRO RISK SCENARIO ASSUMPTIONS AND MARKET OUTLOOK¹
• Coronavirus continues to spread, both in developed and emerging markets. Some seasonal relief in
Northern Hemisphere, but infections pick up in Southern Hemisphere going into their winter. Virus picks
up again into North’s winter.
• Chinese production continues to return, but some disruptions remain in place.
• Moderate global supply chain disruptions.
Base Case: • DM growth slips as virus-containment measures hit economies. Impact on DM economics moderated by
Coronavirus Drags better health systems.
• Soft environment for oil and other commodities.
On Global Growth • Fed follows up the 50bp intermeeting cut with another 25bp cut in the spring due to a/ risk from broader
(45%) virus spread and b/ signs of slower growth.
• Lower rates support growth, but cannot fully offset negative supply shock. Notably slower US growth.
• Other DM countries have less policy space to respond, though some modest further loosening.
• Growth knock-on effects across EM, commodities an important channel. Countries with policy space lower
rates in an attempt to provide some offset.
• Corporate profitability drops.
• Disruptions due to the coronavirus are mostly limited to Q1; growth rebounds partially into Q2 and more
fully in Q3.
• End result is mostly more of the same: a/decent but uninspiring US growth of around 1¾%; b/ European
growth improves back toward 1½%, substantially narrowing the differential with US and c/ EM growth
V-Shaped Post- also drifts up modestly.
• Fed stands pat at March meeting waiting to see effect of 50bp cut. Better news on virus spread into
Coronavirus spring leaves them on hold. Wages move toward 3½%; Fed still notes lower-than-desired inflation.
Rebound; Not • Expectations are for the US election to result in gridlock—either Trump or centrist Democrat with the
Significant US House and Senate remaining Democratic and Republican respectively—resulting in only modest changes
to broad macro policy.
Political Disruptions • Trade “phase one” deal sticks, current tariffs remain in place. Back-burner until after the election but no
(25%) lasting resolution.
• ECB shows little appetite for further monetary stimulus. Modest fiscal loosening for the Eurozone as a
whole, but no sign of a substantial package.
• EM growth of just over 4%; growth differential to US widens relative to 2019.
• Corporate profits grow, but slowly.
• Growth slows further from combo of coronavirus, fiscal drag and trade tensions. Market concerns about
sustainability of profits leads to an equity sell-off and spread widening. Non-linear dynamics take over—
the US tips into recession.
• Unemployment rises notably (~2.5pp). Recession is mild: the 2001 shallow slump rather than 2009.
• The Fed cuts rapidly and deeply in response; rates are quickly taken back to the ZLB and forward
guidance reinstated. Either QE restarted or rate caps on longer-term rates; short-term rates at 0.
Shallow Recession; • The US electorate reacts as they typically do to a recession: tossing out the party in power. Democrats, led
Progressive Democrat • by one of the left-wing options.
With little policy space to respond, Europe and Japan also enter mild recessions. ECB cuts a further 10bp
Wins Landslide (20%) and substantially increases the size of asset purchases along with ongoing discussions about buying
equities in size.
• EM growth decelerates rapidly; some countries see output contract. Flight to quality boosts dollar against
EM.
• Expectations for a substantial increase in US anti-trust enforcement. Healthcare reform mooted. Russia
sanctions a very real possibility.
• Corporate profitability takes a substantial hit.
• Growth acceleration into the coronavirus episode more rapid than realized. The effects of the virus prove
largely transitory but policy eases in response and pushes growth higher. V-shaped recovery.
• Largest growth pickup is in Asia, but the firming also extends to the rest of the world. Other EM
economies also benefit. US growth picks up while Eurozone growth improves to ~1½%.
Cyclical Rebound • In the US, core PCE inflation rises to slightly above 2%; the FOMC treats the acceleration as a positive
Combines with Policy development in context of framework review.
• Fed remains on hold through the election cycle; expectations of modest 2021 rate increases build.
Easing To Push EM • Trade issues remain on the back-burner.
Growth Higher (10%) • Oil drifts up. Commodity exporters broadly benefit.
• Trump wins easily. Republicans narrow the size of the Democratic House majority and pick up a couple
Senate seats (MULTI-ASSET CREDIT TARGET ALLOCATIONS (%) SINCE INCEPTION AND RECENT ALLOCATION CHANGES2
30 Allocation Changes3
Month Change (%)
25
22.5 EM Local Currency May-June 2019 -5.0
22.5
20 EM Hard Currency Dec-Jan 2020 +5.0
15 15.0 EM Corporates May-June 2018 +1.5
Euro High Yield Oct-Nov 2019 -3.5
10 10.5 10.5
US High Yield Dec-Jan 2020 -5.0
5 5.0 5.0
6.0 Loans Nov-Dec 2018 -5.0
3.0
Securitized Mar-April 2019 +1.0
0
IG Corporate Aug-Sept 2019 +3.0
Treasuries/Cash Oct-Nov 2019 +3.5
3
Latest allocation change
High/Low Range Current
2
Since Inception: September 2013. Multi-Asset Credit Representative Target Allocation as of 31 January 2020. Actual allocations within any account may be significantly different
from the target allocations shown here. For illustrative purposes only.
JANUARY CREDIT MARKET TOTAL RETURNS & ATTRIBUTION
US High Yield EM Hard Loans EM Local EM Corp Euro High Yield IG Corporate
Total Return 0.00 1.52 0.56 -1.29 1.54 0.20 2.07
Duration 1.15 2.96 0.16 2.15 1.73 0.46 2.42
(Returns from Interest Rates %)
Credit Beta -1.15 -1.44 0.40 -3.44 -0.19 -0.26 -0.35
(Returns from Spreads %)
Credit Market Total Returns reflect performance of representative asset class benchmarks. US HY: ICE BofAML US High Yield Constrained Index; EMD: J.P. Morgan EMBI Global
Diversified; Loans: S&P/LSTA Leveraged Loan Index; EMDLC: J.P. Morgan GBI-EM Global Diversified; EMDCR: J.P. Morgan Corporate Emerging Markets Bond Index Broad
Diversified; EUR HY: ICE BofAML European Currency High Yield 2% Constrained Ex Financial; IG Corp: Bloomberg Barclays Global Agg Corporate Index. Past performance is not
a guarantee of future results. Index performance is calculated on a total return basis with dividends reinvested and do not reflect the impact of management fees. Investments
may not be made directly in an index. For illustrative purposes only.
4 • Stone Harbor Investment Partners / Investment Policy StatementStone Harbor Investment Partners
• Institutional fixed income investment firm focused on credit risk strategies and asset allocation.
• 100% employee-owned
• Over 25-year performance history
• Offices in New York, Chicago, London, Singapore and Melbourne.
• Total assets under management: USD 19.8 billion as of 31 December 2019
Stone Harbor Investment Partners LP manages institutional clients’ assets across a range of investment products including multi-sector credit, emerging markets debt, core fixed
income, securitized, high yield, and bank loan strategies. Across all strategies, we seek to generate attractive risk-adjusted returns through a disciplined process of fundamental
credit analysis complemented by solid portfolio management skills and sound risk management. Experience, teamwork and dedicated client service - the cornerstones of our
success - help us achieve sustainable results.
New York Chicago London Melbourne Singapore
31 W. 52nd Street 10 S. Riverside Plaza 48 Dover Street Suite 3143, Level 31 9 Temasek Boulevard
16th Floor Suite 875 5th Floor 120 Collins Street #09-03A Suntec Tower Two
New York, NY 10019 Chicago, IL London, W1S 4FF Melbourne Singapore 038989
+1 212 548 1200 +1 312 492 4251 +44 20 3205 4100 +61 3 9225 5064 +65 6671 9711
Multi-Sector Investment Global High Emerging
Credit Grade Yield Markets
Indices referred to herein are broad-based securities market indices. Broad-based securities indices are unmanaged and are not subject to fees and expenses typically associated
with managed accounts or investment funds. Investments cannot be made directly in an index.
Index Definitions
The J.P. Morgan CEMBI Broad Diversified (CEMBI Broad Diversified) tracks total returns of U.S. dollar-denominated debt instruments issued by corporate entities in emerging
market countries and consists of an investable universe of corporate bonds. The minimum amount outstanding required is $350 mm for the CEMBI Broad Diversified. The
CEMBI Broad Diversified limits the weights of those index countries with larger corporate debt stocks by only including a specified portion of these countries’ eligible current
face amounts of debt outstanding.
The J.P. Morgan EMBI Global Diversified (EMBI Global Diversified) limits the weights of those index countries with larger debt stocks by only including specified portions of
these countries’ eligible current face amounts outstanding. The countries covered in the EMBI Global Diversified are identical to those covered by the EMBI Global.
The J.P. Morgan GBI-EM Global Diversified (GBI EM Global Diversified) consists of regularly traded, liquid fixed-rate, domestic currency government bonds to which
international investors can gain exposure. The weightings among the countries are more evenly distributed within this index.
The ICE BofAML European Currency Non-Financial High Yield 2% Constrained Index contains all non-Financial securities in The ICE BofAML European Currency High Yield
Index but caps issuer exposure at 2%. Index constituents are capitalization-weighted, based on their current amount outstanding, provided the total allocation to an individual
issuer does not exceed 2%. Issuers that exceed the limit are reduced to 2% and the face value of each of their bonds is adjusted on a pro-rata basis. Similarly, the face values of
bonds of all other issuers that fall below the 2% cap are increased on a pro-rata basis.
The ICE BofAML U.S. High Yield Constrained Index (HUC0) contains all securities in ICE BofAML U.S. High Yield Index but caps issuer exposure at 2%. Index constituents are
capitalization-weighted, based on their current amount outstanding, provided the total allocation to an individual issuer does not exceed 2%. Issuers that exceed the limit are
reduced to 2% and the face value of each of their bonds is adjusted on a pro-rata basis. Similarly, the face values of bonds of all other issuers that fall below the 2% cap are
increased on a pro-rata basis. In the event there are fewer than 50 issues in the Index, each is equally weighted and the face values of their respective bonds are increased or
decreased on a pro-rata basis.
The MSCI World Index is a broad global equity index that represents large and mid-cap equity performance across all 23 developed markets countries. It covers approximately
85% of the free float-adjusted market capitalization in each country.
The S&P 500 Index is a stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the United States.
The S&P/LSTA Leveraged Loan Index is a partnership between Standard & Poor’s and the Loan Syndications and Trading Association, tracking returns in the leveraged loan
market and capturing a broad cross-section of the U.S. leveraged loan market - including dollar-denominated, U.S.-syndicated loans to overseas issuers.
The Bloomberg Barclays US Aggregate Index is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds
traded in the United States
The Bloomberg Barclays Global Aggregate Bond Index provides a broad-based measure of the global investment grade fixed-rate debt markets. It is comprised of the U.S.
Aggregate, PanEuropean Aggregate, and the Asian-Pacific Aggregate Indexes. It also includes a wide range of standard and customized subindices by liquidity constraint, sector,
quality and maturity.
Important Disclosures
This material is solely for informational purposes and should not be viewed as a current or past recommendation or an offer to sell or the solicitation to buy securities or
to adopt any investment strategy. The opinions expressed herein represent the current, good faith views of the author(s) at the time of publication and are provided for
limited purposes, are not definitive investment advice, and should not be relied on as such. The information presented in this material has been developed internally and/or
obtained from sources believed to be reliable; however, Stone Harbor Investment Partners LP (“Stone Harbor”) does not guarantee the accuracy, adequacy or completeness
of such information. This material includes statements that constitute “forward-looking statements”. Forward-looking statements include, among other things, projections,
estimates, and information about possible or future results related to market, geopolitical, regulatory or other developments. Any forward-looking statements speak only as
of the date they are made, and Stone Harbor assumes no duty to and does not undertake to update forward-looking statements. Forward-looking statements are subject to
numerous assumptions, risks and uncertainties, and are based on current market trends, all of which change over time. The views expressed herein are not guarantees of future
performance or economic results and involve certain risks, uncertainties and assumptions that could cause actual outcomes and results to differ materially from the views
expressed herein. The views contained in this material are subject to change continually and without notice of any kind and may no longer be true after the date indicated.
All investments involve risk including possible loss of principal. There may be additional risks associated with international investments involving foreign economic, political,
monetary and/or legal factors. These risks may be heightened in emerging markets. Past performance is not a guarantee of future results. This material is directed exclusively at
investment professionals.
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